Finance: Learning to re-balance a portfolio

PHUKET: Portfolio re-balancing is one of the trickier aspects of investment management, as you will inevitably need to make some hard and counterintuitive decisions to ensure that your portfolio’s asset allocation continues to meet your investment goals and risk-tolerance level. But why, how and when should you re-balance your investment portfolio?

WHY YOU NEED TO TAKE WINNERS AND LOSERS OFF THE TABLE

Selling investments that have been big winners in the past in order to reinvest the proceeds in investments that have not performed as well (e.g. selling equities for bonds) will take a considerable amount of mental discipline on your part. After all, the “buy low, sell high” investment strategy works, but only if you have the emotional discipline to sell at the high point and not wait for the investment to go even higher.

Moreover, stock market plunges always provide a good reason for periodically re-balancing your portfolio because too many investors, especially retirees or near retirees, entered the dot com bust in year 2000 too heavily concentrated in tech stocks thanks to their run-up in value, while others entered the financial crisis with more than 90% of their portfolios concentrated in equities. These investors presumably failed to periodically re-balance their portfolios, which led to their asset allocations getting completely out of whack and, ultimately, to big and unnecessary losses.

Likewise, you need to periodically cut your losses on losing investments. For example, it may seem like you have nothing more to lose on an investment that’s down 50% as it “could always go back up,” but you need to remember that an investment down 50% will need to rise 100% in order for you to at least break even again.

It’s also important to remember that not only is the market and your portfolio changing over time as asset classes or sectors move in and out of favor, but so are your investment goals and risk-tolerance levels in relation to the performance of the market and your portfolio. This means that even if your portfolio’s asset allocation has managed to remain static, you may still need to re-balance your portfolio to ensure it continues to meet your changing risk profile and investment goals.

KEY RE-BALANCING CONSIDERATIONS

Although portfolio re-balancing is critical for maintaining your investment strategy and for helping you to avoid unnecessary risk, it’s not something you should follow slavishly (e.g. you don’t need to re-balance a 60% / 40% equity / bond portfolio when the equity portion suddenly becomes 60.5%) nor should you automatically re-balance your portfolio’s assets on a set date every year.

Instead, talk to your financial adviser about setting some basic thresholds. For instance, if your asset allocation shifts 5% or more, or some of your investments have made significant moves, then it might be time to set up a meeting to figure out how to re-balance things. In fact, you may need to re-balance your portfolio a couple of times a year in a very active market or you may not need to re-balance it at all.

There may also be times when you need to re-balance your portfolio in order to take advantage of so-called “tactical” opportunities which periodically present themselves. Allocating a portion of your portfolio to beaten down home-builder stocks, which started bouncing back in mid-to-late 2011, would have been a good tactical investment at the time, while now might be the time to take some or all of your profits off the table.

Finally, and before you over-re-balance your portfolio, remember that too much selling out of high performing assets in a bull market or too much buying and selling in general that racks up commissions or fees, can negatively impact your long-term investment returns. In other words, re-balancing an investment portfolio is more of a balancing act and an art form rather than an exact science.

If you have not re-balanced your investment portfolio in some time, call me and we can discuss how to do so.

Don Freeman is president of Freeman Capital Management, a Registered Investment Advisor with the US Securities Exchange Commission (SEC), based in Phuket, Thailand. He has over 15 years’ experience and provides personal financial planning and wealth management to expatriates. Specializing in UK and US pension transfers. Call 089-970-5795 or email: freemancapital@gmail.com.